As the Student Loan Ranger’s various social media profiles fill up with congratulations for this year’s college graduates, we thought it would be a good time to offer a math lesson.
While most federal student loans for the Class of 2016 won’t be due for payment until this fall because of the grace period, we’d like to explain why it might be a good idea to make some payments now. Making payments on your student loans now can be a great financial investment in the long term.
Most federal Stafford and both parent and graduate PLUS loans are unsubsidized. This means that interest has been accruing on these amounts from the day they were disbursed.
While you aren’t required to pay this accrued interest now, these amounts will be capitalized once the loan enters repayment. This means that the accrued interest will be added to the principal balance and the interest will be calculated based on this new, higher balance.
Capitalization can happen at other times as well — generally when you go from a nonrepayment status to a repayment status, when you default or when you change repayment plans or are late renewing your payment plan. These amounts can add up and make your loan a lot more expensive in the long run.
For example, say you graduated with $30,000 in unsubsidized federal student loan debt after four years of school. Even though your loans likely have different interest rates, for the sake of simplicity let’s say they are all at 5 percent. Again for simplicity, we’ll say you received $5,000 on Jan. 1 of both 2013 and 2014 and $10,000 on Jan. 1 of both 2015 and 2016 (in reality, you likely got half of each loan in the fall and half in the spring — the interest on those amounts begins to accrue when they are first disbursed).
[Don’t fall for eight student loan repayment myths.]
So on Nov. 1, 2016, the 2013 loan would have accrued $958.25 in interest over 1,400 days; the 2014 loan, $708.42 over 1,035 days; the 2015 loan, $917.18 over 670 days; and the 2016 loan would have accrued $417.52 in interest over 305 days. Remember, unless and until it capitalizes, interest accrues that doesn’t affect the principal until you make a payment. We picked Nov. 1, as that will be close to the time the grace period will end and any outstanding interest will capitalize.
In this example, if you pay that $3,001.37 total interest before it capitalizes, you’ll be starting out repayment with a balance of around $30,000. If you don’t, you’ll be starting repayment with a balance of $33,001.27.
Over 10 years, a $30,000 loan will have a monthly payment of $318, and you’ll pay a total of $38,184. A $33,001.27 loan, however, would have a monthly payment of $350, for a total of $42,003 repaid.
That’s about $4,000 or upward of 30 percent more in interest paid over the life of the loan. Would you pay 30 percent more for a car, cellphone or a hamburger if you didn’t have to? Probably not.
[Learn how to start student loan repayment off right.]
The best case scenario is that you’ve been paying this interest as it’s accruing, but if not, you can prevent it from capitalizing by paying all of it before your grace period ends. Even if you can’t pay it all, every little bit can make a difference in the total amount you pay on your student loans.
You won’t get a bill for this interest, but you can contact your loan holder for instructions on how to submit a payment. All payments on federal student loans are always applied first to any outstanding fees — if you are in the grace period you won’t have any of those — then accrued interest to date, then the principal. These payment application rules are set in federal regulation so they will be the same regardless of who is servicing your loan.
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